NICK TRAIN, Joint Founder and Fund Manager, Lindsel Train

uying below book or buying

a low P/E stock or going contrarian, you have much to learn from
Nick in. Nick doesn't look for any of the these when hunting for
stocks. He doesn't even try to spot the n
multi-bagger. And yet,
when he finds companies he likes, he keeps them for years. An

every value investor how to invest for value. Read on.

professional, I tried to judge

John Templeton once said, "History
shows that time, not timing, is the key
to investment success. Therefore, the
best time to buy stocks is when you
have money" - a philosophy you share.
Whatwould you do in a 1999 or2007-
like scenario? Continue to invest? Yet
another view says, "Wait till there is
'blood in the streets'." How do Vou
reconcile these two?
I have never suffered from any
delusion that I am an unusually
smart or far-sighted investor. A keen
sense of my many investing
Iimitations means I have had to
keep my approach simple. I am
mostly concerned with avoiding
obviously bad or'losing' investment
behaviour such as over-trading or
backing low-quality companies and
I'm willing to stick with basic
investment principles that seem to
me likely to work over time, even
accepting there will be periods
when they don't.
Your first question is a good
example. For a while, as an
inexperienced investment
whether equity markets were cheap
or expensive. I even allowed myseJf
to express pessimistic views about
market prospects in public and,
worse, to act on them. Now looking
back over the thirty or more years
of my career, it seems to me every
one of those negative calls I made
on markets was just plain wrong.
They've gone up a lot over time and
in hindsight there was always
something to be enthused about.
And iikely there always will be.
Eventually I acknowledged, for
me, the futility of such guesswork
about market levels and concluded
that it makes good commercial,
investment and - perhaps most
importantly - emotionaL sense to be
permanently bullish. This, I believe,
is good, 'winning' investment
behaviour. Being bullish brings a
competitive advantage over the
many market participants who are
either negative because that is their
habitual outlook on life (an outlook
that tends to overstate temporary
problems and to underestimate
human problem-solving ingenuity)
or who back themselves to trade in

40 | Wealth Insight February 2016

February 2016 Wealth Insight 41
 and out of equity markets on the basis Nick Train's
of their hunches about market levels; Career
opposite - I'm an optimistic buy-and- Equities, worry today about a turn in global
my M&c
holder. In this way I put history on
side, given the long-term propensityof lnvestment
Management bonds. But what equity investors
stock markets to go up over time,
Anglo-Saxon ones at least. In addition,
being
I feel a lot better about myself -
optimistic keeps you young!
Admittedly this determined Europe continue to double every two years,
bullishness means that periodically I (latest
am 'long and wrong' about stock position held)' more relevant to the outlook for
markets, including 1999 and 2007. Iotal
This is no fun at the time, but holding
cash when markets are recovering is
even less so.
What amtrding to you, indicates that the
market is expensive or cheap? Arc dividend yields
good indicatoP
In my opinion, nothing reliably indicates
markets as cheap or expensive. For this reason,
as outlined above, I believe it is a better bet to
assume that equity markets are always cheap.
The long-term returns from stocks suggest that
this is not as deluded a proposition as it might
appear to be.
The fact is stock markets are driven by
technology innovation and the associated rise
and fall of industries brought about by that
innovation. As a result, the constituents and
industry weights of markets are always
changing, so trying to judge the value they
offer in relationship to a different historical
period is pointless.
It is wrong to think that stock markets
exist in order to make investors wealthy
This is a possible but by no means certain
outcome. No, markets have evolved as the
most efficient means so far to test and
finance new ideas about how to satisfv
Of all the losing investment
approaches out there, that of being
a pessimistic trader must be the most
certain to lead to disappointing returns
42 | Wealth Insight February 2016
human needs and wants. Investors
fret about the cyclical wobbles of
economies and periodic spikes and
Itl,-
rr II qrr
dips in equity prices but these are
' irrelevant to this central function of
000 stock markets and to their long-term
trajectory For instance, people
interest rates. I understand this is an
issue if you invest in government
about is
holds
will
as it has for the past fifty). This is far
stocks than the vacillations of
interest rates.
term chart of lI
market vou se
accumulation of long-term value is
associated with the emergence of
a new industries, new companies or the
productivity gains brought by new
technology The ups and downs of interest
rates? Not so much.
I'm su.re that if you're optimistic about
technology and innovation, then you should be
optimistic about equity markets. In that sense,
markets are always cheap.
When market yields are below gilt yields, do you
still buy equities or wait it out?
Gilt yields and stock-market average dividend
yields are irrelevant if you have identified a
good equity idea. Good ideas are rare, in my
experience, so buy
Equities, you mentioned in one of your insights,
perfom well in recession years. How do they do
that if eamings are down?
The 'duration'of the stock market can be
thought of as its dividend yield divided into
100. So, a 3 per cent market yield gives a
duration of 33 years. One or two years of
recession-depressed earnings are of little
importance when investors, whether they
know it or not, are looking out over this sort of
time horizon.
You have quoted Deirdre Mcloskey, "a more
reasonable diagnosis... is that booms and busts
arise from unconectable optimism and pessimism
about novelties." Do you see any novelties that can
become a boom-bust scenario ahead?
I certainly hope so. Booms ald busts are
integral to markets and without them they
can't do their job, namely flnance new ideas.
We pejoratively describe booms as manias,
suggesting that individual investors have
become irrational - carried away by greed.
This may be so, but at the societal level these
manias are, in fact, quite rational and
beneficial. We wouldn't have Facebook and
Google without the mania of 1992-2000. And
many treatments for previously intractable
medical conditions will emerge from the
current biotechnology boom.

You ascribe a lot of significance

to dividend-paying
companies. What of companies that skip dividends
to invest in groMh?
Yes, dividends are interesting, particularly
Iong-term dividend histories of industries and
companies, but maybe not for the reasons you
might think. Here's why
Technology change is the big driver of both
wealth creation and destruction. How does an
equity investor respond to its chalienge? Some
Iook to participate in cutting-edge technology
itself and this is probably the most rewarding
approach, particularly if you have a superior
understanding of the technology and the
competitive advantages of the companies you
choose. I do not have this expertise. Instead
I've chosen another response: that of
identifying companies whose value-added is
unaffected by technology change, oq even
betteg companies whose value-added can be
enhanced by applying technology to its
existing franchise. For example, Burberry is a
company whose brand and heritage have made
its products desirable for well over 100 years.
And Burberry is now demonstrating how the
deployment of digital marketing techniques
can make its brand and heritage even more
aspirational. Technology can't
disintermediate Burberry's products as it
might, say a telephone company But the
company czui use technology to reach more
customers and understand them better.
This means that longevit5l tradition and
predictability are important investment
criteria for me. If a business has not iust
Nothing reliably indicates markets
as cheap or expensive. I believe it is
a better bet to assume that equity
markets ale always cheap.
survived but thrived over previous periods of
technology change, then there is a possibilit5l
never a certainty that it will continue to do
lnvestment
so. For this reason, I am interested in the principles
long-term dividend histories of companies. If followed
a company has proven capable of paying Investors
growing real dividends over long periods, it is undervalue
a signifier that here is a business model or durable, cash
generative
set of assets that has retained relevance and
business
offered protection against past disruptive franchises.
technology change and the effects of
Goncentration
monetary inflation. Of course, the past is no can reouce
certain guide to the future. But I prefer to risk.
start from identifying existing great, durable Transactlon
franchises and asking what could hurt them costs are a
rather than trying to predict the next 'tax' on
generation. If at all possible, I avoid retu rns.
companies that appear to be certainly Dividends
vulnerable to technology change, however matter even
more than you
'cheap'they may appear. That seems to me to
think.
be the most difficult approach of all.

February 2016 Wealth Insight | 43


Longevity, tradition and
predictability are important
investment criteria for me
44 | Wealth Insight February 2016
You hold companies for many years. When, in your
view, does a company start losing the plot and is on
the sure path of decline? Are there any indicators?
I don't like it when a theoretically cash-
generative business model stops generating
free cash. AIso if debt builds up for no good
reason, alarm bells ring. A long time ago I
made a bad mistake investing in the music
industry I failed to understand how technology
was unravelling the record iabels' superior
economics based on copy'right. The problems
soon showed up in falling free cash flow and
rising debt. I should've reacted quicker.
Generally though I agree with Buffett that
investors are too ready to sell out of
investments, that they are too confident that
doing something, as opposed to nothing, will
make a positive difference. It seems to me
that it is more likely that experienced, smart
managers of a company with temporary
problems will find a solution to those
problems than that I will successfully switch
out of said challenged company into a better
one. That might sound defeatist, but in a
competitive capital market, with other
investors highly alert to risks and
opportunities everywhere, it is hard,
particularly after costs, to demonstrate that
regularly trading in and out of companies
adds value.
Why is mismanagement of retained earnings
significant? Are there any indicators that signal
such mismanagement?
Sadly not until it's too iate.
What is a baggefi What are the qualities you look
for in a bagger (or in a prospective investment
stock) and what not?
A bagger is a stock that goes up multipie
times on its purchase price. So far as I know
the first investor to use the term and to build
an investment approach around looking to
capture as many baggers as possible was
Fidelity great Peter Lynch. But credit too to
Bill MiIIer, whose dictum "He who has the
Iowest book cost wins" expresses a similar
idea. It seems almost a poiniless truism that
the best investment you can make is one
which rises many times over and that you
never have to sell. But my observation is that
few people invest in such a way as to give
 themselves the best chance of multiplying
their capital because they're always, as the
cliche runs, pulling up the plant to look at
the roots.
In the end, I think there is a psychological
factor here. There are those who love to trade
- to take cutely timed profrts and move on to
the next idea. Variety keeps them engaged.
Then there are the hoarders. People who
painstakingly accumulate holdings in valuable
companies over the years, harbouring them
during periods of underperformance, buying
more on the dips - monitoring the gradual
build-up of book value and dividends over
time. It takes patience. Both are equally valid.
Perhaps the most important learning for every
investor is to figure out what psychological
, type they are.
An old friend of mine - an investment
banker actually - Iikes to point out that the
dividend per share he receives today from his
longest-standing personal equity holding is
higher than the price per share that he paid
for the stock - although, admittedly it was
purchased 25 years ago. Isn't that amazing?
Only equity can do that for you. But you have
to own the right company and you have to be
patient. I always teII our clients that we
expect to be invested in the companies we
commit their capital to for a long time. We're
looking to stay invested over the course of
several business and stock-market cycles -
way way longer than many professional
invegtors. Of course, this sort of strategic
approach is not perfect. We're not nimble -
not because we couldn't be, but because we
don't choose to be. We'll hold
underperforming businesses and shares
maybe for too long. But there is a big benefit
too in what we do. We're giving ourselves and
our clients the best-possible chance to benefit
from compounding, which takes time.
Never invest in any
company that makes
anything out of metal. And if
you find a company whose
products taste good, buy the
shares.
GF Lindsell Train UK Equity Fund
Performance is for the CF Lindsell Train UK Equity Fund Acc Shares. This fund is a UK-domi-
ciled retail scheme, with an inception date of July 10, 2006. Perfomance is provided net of
fees in GBP (management fee 0.65% p.a. and TER 0.77% p.a.l. The fund's benchmark,
FTSE All-Share, has been provided for companson purposes.
OFund net returns (GBP%) Index returns (GBP%)
t4
July 2006
Both, in your UK Equity Fund and the Global
Equi$ Fund, you have no investments in
commodities, industrials, mines, cement, steel
and real estate. Why?
Investing is challenging - both intellectually
and emotionally I prefer to avoid investing in
industries which I know for sure have gross
cyclicality of earnings and./or which rely on
borrowings to make their returns. I'm not
saying there aren't great opportunities to make
money in these sectors. It's just that you
always have to remember to sell and I, being a
hoarde4 prefer to own stuff I hope I never to
have to sell.
Favourite
My two favourite pieces of investment
books
advice help explain these preferences. 'Never
Wanen
invest in any company that makes anything Buffet Way
out of metal'. And'If you find a company Hagstrom
whose products taste good, buy the shares'. By One Up on
and large those two rules have helped me avoid WalI Steet
the worst investment errors and pointed me to Lynch
some of my best ideas. Stocks for
the Long Run
In some stocks, with high dividend yields, is therc Siegel
not a dsk of getting into a value trap, wherc the Big Short
Lewis
stock behaves like an annuig but does not offer
much long-term stock pdce appreciation? How do What
you identiff and do you in in such stocks?
Technology
Wants
Just never buy anything for dividend yield
alone.
Kelly.
February 2016 Wealth Insight | 45
 In a recent interview, you said you have not bought
Leisure anything new for the last four years. What did you
activities mean, and what did you do during that period? Do
Spend time you wait for a fat pitch, as Buffett says? How long?
with family Yes, I've just been through a four-year drought
Reading when no new idea seemed sulliciently
Yoga compelling to supersede existing holdings. I've
been lucky enough over that period to enjoy
strong flows into my fund and had no problem
investing that cash into the current
constituents. Doesn't Buffett say somewhere,
"Often the best idea for new money is to buy
more of what you already own?" I think it's
interesting that this four-year period has
coincided with a streak of competitive
absolute and relative performance from the
strategSz Activity is overrated!
Exceptional oompanies with durable competitive
advantages arc often not cheap. Would you buy a
Diageo at 40 or 50 times eamings? What is the
maximum you would pay for such companies in
terms of eamings multiples?
Actually I'd argue the opposite. To me it
appears tJrat'exceptional companies with
durable competitive advantages' are in fact
cheap almost all the time.
The point is such companies are rare. It is
plain wrong to expect them to be valued
similarly to what is the vast majority of
ephemeral, Iow value-added businesses. I like
to think about the conundrum of 20. Many
investors presented with a stOck on 20 times
earnings - Diageo for instance - will say that's
expensive, relative to, for example, the long-
mn average P/E multiple for Anglo-Saxon
markets of 15. Howeven if I offered those
same sceptical investors the opportunity to
invest in an asset with a guaranteed 5 per cent
yield, with likely protection against inllation
over the next 25 years, with some real, above-
inflation growth thrown in too, they'd fall over
themselves to buy Diageo seems to me to offer
such potential, by the way Yet, of course, the
'high'P/E of 20 and the attractive real yield of
5 per cent are one and the same.
Exceptional companies with durable
competitive advantages are cheap
almost all the time
46 lWealth lnsight February 2016
So. a rule of thumb for me is that an
exceptional business cal easily justify a
valuation up to 30 times earnings or a real
earnings yield of over 3 per cent. After all,
idlation-protected government bonds are
keenly bought by investing institutions today
with starting yields of lower than 1 per cent.
How can investors use the gilt rate to come up with
a discounting rate to anive at the intdnsic value?
Can you explain with examples?
I do use the long gilt yield as a discounting
rate, but it is important to understand that any
resulting measure of value is very imprecise.
To my mind, the real benefit of the exercise
is the questions it forces you to answer about
the company you are proposing to value. The
Iongest dated government bonds have lives of
30 up to 50 years. If you're going to use these
instruments to value an equrty then first you
must have a reasonable expectation that the
company will have a similarly long life.
Otherwise, you are not comparing like with
like. Of course, most companies will not
survive for 30 years or more. Most companies
fail. So just applying this filter -'will such and
such a company likely be around in 30 years?'
- savagely reduces the universe of potential
investments for me. But every so often you
come across a business with a brand or a
franchise that has survived and thrived over
many decades and where it doesn't seem
totally absurd to expect it to continue to do so.
Then you can start thinking about its value
compared to a long bond. The next question is
-'how likely is it that this durable corporate
asset will be able to grow its cash earnings
over the next 30 or more years ahead of the
rate of fullation, whatever that turns out to
be?'Again, this is another unanswerable
questioq but again history suggests few
companies are able to maintain the real value
of their products or services over time.
But say you decide that Diageo's brands,
Johnnie Walkeq Guinness, Captain Morgan
etc., are likely to at least maintain their real
pricing power over the next three decades and
might even offer some inllation-beating
volume growth too, as the world's spirit
drinking population grows. If you have made
that decision, then you're immediately faced
with the critical question at the heart of our
investment approach. Why should Diageo, or
 any other of these rare wonderful
corporations, be valued at less than a
government bond? We know for sure that the
bond wiII pay its fixed coupon for the next
30-50 years. That's something. But we also
know for sure that the government bond will
be unable to protect investors against the
effects of unanticipated monetary inllation
over time because the coupon is fixed.
--'-.--'-Meanwhile,
we've already agreed that
rJrageo wiII not only have survived over the
Iife of the long bond, it will likely in
addition, have grown its earnings ahead of
inflation. This means Diageo ought to be
worth very much more than a government
bond to a long-term investor. But when you
look at current valuations, you find that
this is not the case. The longest UK gilt has
' a redemption yield of 2.4per cent, or a P,/E
of 47.7 (L00/2.4).In contrast Diageo trades at
a prospective P/E of 20 (according to
Bloomberg) or a yield of 5 per cent (100/20).
If Diageo were to be valued just in line with
the UK long gilt, it should today be trading
at 840, rather than its market price of f,18.
And there is a clear case to argue that
Diageo ought to be worth more than a gilt
because of the likely real growth it offers.
The above is in no sense a formal target
price for Diageo. I don't know any certain
way of arriving at the 'correct' value of any
asset. What I do know though is that I've
been asking the right questions about the
attraction of any equity asset. And the
thing is history supports the proposition
that those companies that do succeed in
growing real value over long periods of
time are not only rare, they are also
extraordinarily valuable.
India's bank deposit rate is about 8.5 per cent.
Should this be the minimum yield rate to demand
from quality stocks? What if the yield rate offered
by high-quality stocks is lower than 8.5 per cent?
Companies that glow
* real value over long
periods of time are not only
rale but also extraordinarily
valuable
Lindsell Train Global Equity Fund
Performance is for the Lindsell Train Global Equity Fund B-Class shares. This fund is Dublin-
domiciled, with an inception date of March 16,2011. Performance is shown net of fees (man-
agement fee 0.65% p.a. and TER 0.79% p.a.). The fund's benchmark is the MSCI
Developed World and this is shown for comparitive purposes.
OFund net returns (cBP%) I Index returns (GBP%)
9
6
0
-5
-6
-9
March 2011 December 2015
Source: l\4orningstar Direct
Should one wait for markets to cool down or yield
rates to go up?
No. Short-term interest rates have no
bearing on the long-term value of a real
asset like a quality stock. Given long
enough, its share price wiII correlate
perfectly with its growth in free cash flow.
How do you value whether a company is
undervalued or overvalued: DCF, free cash
flows or private market value, or a combination
of all?
On my time horizon, the calibre of a company
is much more important than its value. You
can be wrong about value in the short term,
but still have a great investment over time. My
worst errors have come from overestimating a Favourite
company's business model, not overestimating sectors
the worth of a fine companlz Consumet
That said, I pay a lot of attention to M&A branded
activity in the sectors that I invest in. One goo0s
actual transaction - when serious business Media
people, staking long-term corporate capital, (including,
are prepared to buy or sell 100 per cent of computer
the equity of a business - is worth dozens of
software)
investment-bank research notes. Pharma
(including
healthcare)
When should a person sell a long-term ' Retail
financial
investment and when not? servtces
Best to never sell.
February 2016 Wealth Insight | 47
 Dxcerpts from Nick TFain's
'Investment Insights'

NickTrain authors'lnvestment Insi hts', which can be

followin excerpts are just a sample of the wisdom that

Lynch Law and to go fishing where stocks are

August 2OI5
built his
I'Iamously Lynch
investment performance around
l{
I "baggers" - shares that doubled.
trebled, sextupled or better over time.
Magellan benefited from over a hundred
"l0-baggers" during his stewardship.
Think about that. Few of us are lucky
enough to identify and, crucially, have
the fortitude to hang onto, 10, Iet alone
100, stocks that go up 1000%. It might
sound obvious, but you don't get to
enjoy those sorts of gains if you sell
out early. Yet all the psychological
pressure is to take profits on winners
down and "cheap".
Another investor we admire,
Richard Oldfield, wrote a stimulating
book with a brilliant title. "Simple but
not Easy" And it is true, because Lynch
demonstrated it in his own career, that
investment can be simple. It can be sim-
ple in that the ideas that make the best
returns over time do not have to be
intellectually abstruse. For instance,
one of Lynch's key rules
was to watch out for
where your household
shops and what for.
It's important when
your wife tells you

48 | Wealth Insight February 2016

that M&S has lost the plot in kids' wear. It's Sir John "forgot more than we'll ever know
important that you respond to the realisation about" equity markets. Today we recommend
that you buy a Cadbury Crunchie every time investors dwell on the following:
you fill the car. These are not complex ideas. "To buy when others are
"Know what you own." But the practice of despondently selling and LynCh
investment is not eas5r What makes it hard are
noise and distraction. Lynch wanted the pri-
are wanted the private
:T:ll,Ti}others
vate investor to understand that his or her requires the great- investor to understand that
ideas can be just as valid as those of the profes-
his or her ideas can be just as
sionals and that for some professionals sitting ;:rf,T'j}ff"t$
all day in front of scrolling news and price ieward.'," valid as those of the professionals
feeds can distract and detract from the deliverv
of investment returns.
to
"rhe time and that fOr some professionals
buv stocks is
Common Sense never goes out of fashion. *ii"",n",n*, sitting all day in front of scrolling
term owners have neWS and priCe feedS can dis-
finished their sell-
ing, and the time to tract and detract from the
sell a stock is when delivefy Of
Men more frequently the short-term owners
fetgfns
require to be reminded have finished their buying."
"Too many investors focus on
than taught "outlook" and "trends". Therefore,
January 2OI4 more profit is made by focusing
on value."
( (T ynch ran his winners, arguing that 'An investor who has all the
I _if a share has done well - at least answers doesn't even understand the
I-/for reasons that are explicable and questions."
not wholly speculative - then there is every And my favourite - "History shows that
reason to expect it to continue to do well time, not timing, is the key to investment suc-
(although always remembering that nothing cess. Therefore, the best time to buy stocks is
goes up in a straight line). He (and we) dispute when you have moneSr"
the conventional wisdom that says: "It's never
wrong to take a profit". It can be very wrong. If
by doing so you permanently red.uce your
interest in a great long-term investment. Share
prices of the best companies double, then Size doesn't matter
double again and again over time. Locking into
that observed propensity for wonderful
(very much)
businesses to compound wealth for their July 2OI4
owners is at the heart of our approach." ( 6T" our UK Equitv Fund rrye orvn:
T
J.
World's #l Emerging Market FMCG
"l forgot more than Company (Unilever)
World's #1 Spirits and Dark Beer Company
you'll ever kno (about (Diageo)
World's #1 International Beer Brand
(Heineken)
Jan 2OO8 World's #1 Educational Publisher (pearson)
World's #2 Index Service Provider (LSE, post
ir John Templeton's "Investment Russell)
Maxims" and other words of wisdom are World's #1 Scientific Publisher
always worthy of consideration. Truly (Reed Elsevier)

February 2016 Wealth Insight | 49

 World's #1 Online Newspaper (MailOnline)
World's #1 Trading and Investment
Infrastructure Software Provider (Fidessa)
World's #5 Most Valuable Luxury Fashion
Brand (Burberry, according to Interbrand
survey)
World's #1 Chocolate Company (Mondelez)
World's #1 Business Information Provider
(Thomson Reuters)
What we're conveying here can be sum-
marised as "size doesn't matter" - that much.
In our opinion our portfolio comprises a collec-
tion of exceptional brands and franchises,
many so at global level, or if not, strong region-
al or national champions. What is attractive
about them has nothing to do with
Pearson ""11#::ffffX1T11'";
iS nOt aS bi$ aS couldbsdescribedas
Apple, in fact it is only '
ur
1,/36 th of the size. Yet,
arguably, Apple needs Pearson thatdoesnot
more than vice versa in order #:illi:'JHI",
to achieve their separate
ambitions in tr bi
EdTech. is on
size. Yet, arguablY, APPIe
needs Pearson more than vice versa in
order to achieve their separate ambi-
tions in EdTech...Biggest is not neces-
sarily best."
An old-timer looks back
November 2006
(6 ne of GT Management's founders,
Richard Thornton, taught his
young fund managers an
important lesson. "Great money-making ideas
are rare" he'd say, "make sure that when you
find one, you make it count". Indeed, here is
Richard's 4-point action plan for investment
SUCCESS:
Our portfolio comprises a collection of exceptional brands. What is
attractive about them has nothing to do with their market caps'
50 | Wealth Insight February 2016
o Identify your great investment idea.
o Buy as much of the idea as you feel comfort-
able with.
o Buy the same amount again, so you can no
Ionger sleep at night, because of the size of
your holding. Finally
oTELL EVERYONE ELSE ABOUT IT!
This advice can be summarised, in contem-
porary parlance, as to build "high conviction,
highly concentrated" investment portfolios."
ardines and soap
May 2006
he story goes that sometime in the early
years of the Twentieth Century there
was a lull on the trading floor of the
New York Stock Exchange, a IuIl that extended
from hours into days - and the boys were
getting bored and restless. Come an afternoon,
for want of any better entertainment, one of
the traders pulled out an elderly sardine tin
and announced his willingness to seII this
unique item for no more than a nickel. In a
moment two jobbers from the Railroads pitch
had bid and counter-bid for the tin, pushing the
price up to a dime. Not to be outdone, the
swells who trade Texas oil stocks jump in,
doubling the price of the sardines, then
doubling it again. The tin passes from
professional hand to professional hand, with
the ticket sometimes a cent or two higher,
sometimes up a quarter. At last the hubbub
attracts the attention of the baby of the floor, a
wet behind the ears college kid. He spots the
unusual label and can't miss the excitement in
the open outcry yelling of the traders. The kid,
determined to show he can play with the big
boys and genuinely intrigued by the apparent
rarity of the item, firmly calls out "Ten bucks"
and is delighted when the bidding comes to an
abrupt end. Hefting out his pocket-knife, he
punctures the tin, only to be met with the
unmistakeable stink of rotting fish.
Bewildered and heavily out of pocket, the new
boy turns to one of his elders and betters, who
 It is not dangerous for defensive stocks to be apparently highly valued,
compared to the average, mediocre company. They deserve to be.
had taken ahalf Dollar turn out of the tin an
hour previously "I don't get it" says the kid,
"these sardines are long gone." "Son", says the
old jobbef "those weren't eating sardines,
thems were trading sardines."
We're fond of this apocryphal story which
illustrates one aspect of the workings of capi-
tal markets. We aII know about the ramped
"concept" stock, the speculative issue that
almost unaccountably captures the attention of
traders and the investing public. This is the
kind of stock whose appeal begins and ends
with the prospect that it might go up a lot in a
short period of time. Sometimes an entire sub-
sector of the market is implicated, or even cre-
ated, in the excitement. If you play the game
and, we must admit, we tend not to play this
type of game, then one important thing is to
not be the patsy who pays top Dollar. The other
consideration is knowing, if and when the
music stops, whether you hold trading or eat-
ing sardines. There were many months after
March 2000 and many rallies, when it was pos-
sible to sell out of various Internet "trading"
sardines, not at the top, assuredly but before
the things reverted to penny stock status.
A new Nifty Fifty? Bring
it on!
December 2072
rent, we
l'l i's
J- Nifty
Fifty episode in his invaluable book - "Stocks
for the Long Run" (2nd Edition, 1998) and I crib
what follows from him.
The share prices of the Nifty Fifty - that col-
lection of "one decision" stocks (the recom-
mended decision being "buy and hold forever")
and identified by Morgan Guaranty Trust -
peaked in December 7972.It was a disparate
group, comprising some consumer staples, but
also technology companies, retail and industri-
als. And at the peak the shares commanded
expensive valuations, by traditional measures.
The average P/E ratio for the group was 42x,
with a dividend yield of 1.1%, respectively dou-
ble and half that of the S&P500 inL972.
But what really is dynamite (and, reader for-
give me, here I arrive at last at the real point of
this lengthy piece) is that it is by no means
obvious that the Nifty Fifty was materially
overvalued, even at its peak. With the benefit of
25 years hindsight, Siegel worked out the
return on the Fifty from its peak, compared to
the benchmark.
Notwithstanding a nasty
Iurch down inl974/5the Sometimes
group returnedl2.To/o
pa to December an entire subsector of
1997, compared to the market is implicated, or
even created, in the excitement.
iX1lti"j,T#91 , you play
wash. what,s ,f the game and, we must
more, for a typi- admit, We tend ngt tO play this type
cal real world
investor, that is 0f game, then one important
higher rate us "
tax- thing iS tO nOt be the patsy
payer, the Nifty
Fifty would have actu-
who pays top
ally outperformed the Dollar.
S&P because of the lower
dividend yield on the Fifty (capital
gains being taxed more lightly than divi
dend income).
Let's be clear what Siegel is saying. A
collection, however arbitrarily selected, of
"great" companies outperformed the broader
market over 25 years (for the likely average
investor), even from the point of its highest rel-
ative valuation and despite the list containing
more than several that turned out to be real
clunkers. In short, 42x earnings turned out not
to be expensive.
Here's how Siegel summarised his findings:
"Those stocks that sustain growth rates above
the long term average are worth their weight
in gold, but few live up to their lofty
expectations."
And, even more apposite to this discussion:
"Stocks with steady growth records are worth
30, 40 and more times earnings."
In other words and turning to today's debate,
it is not so dangerous for defensive stocks to be
February 2016 Wealth Insight | 51
 quality than those of the
[Gadbury's] assets are of significantly better
average UK company and therefore deserve to be valued more highly
apparently highly valued, compared to the invented. in the 1930's and now account for
average, mediocre company' They deserve to 50.0% of international cough drop sales' This
be. What is dangerous, though, is to be compla- makes the Hall's brand not only the ieader of
cent about their perceived defensive qualities' the world medicated confectionary market,
Oniy the most exceptional sustain very Iong with a share of 22.0%,but also the top global
steady growth records' sugar confectionary brand, with a 2.0% share -
goodness knows how many packs of HaIIs nes-
tle in the bottom of grandmothers'handbags,
alongside the Trebor Extra Strong Mints
(established in 1935, owned by Cadbury and the
Hitting the twentY-Year UK's number one sweet brand by size)' Back in
the 19?0's, Dominic Cadbury, then chairman of
sweetie spot the family business, made a proud boast -
June 2005 "schweppes will still be being mixed with gin
is long after North Sea oil runs out". Of course'
t/ t/ ur starting Point n
here in 2005, those reserves are indeed deplet-
I^' f tnat the best share
l -rt rrt".. irt"t you buv ing, encouraging investors to fund speculative
some point in the distant future, Iet us say surveys for oil as far away as the Aegean Sea'
twenty years, is worth man)1 many times what When, periodically, such appraisal wells prove
you Paid for it. to be dry, those same investors will doubtless
whataboutCadburY? console themselves with several stiff
QVgf So,
Schweppes and Gordons (Iet's include a Diageo
*"il "
the last decade ff"tilXr'l?:i: brand in this pantheon of "predictabies") -
per share itable companv' with proving Dominic Cadbury's earlier prediction'
Cadbury's EBITDA
The longevity of Cadbury's brands and their
is up 7}.6o/o,while Northern's is
?::1X':i:fAT*' proven capacity to generate cash mean that
down L7.OYo.We think anyone years averaging these assets are of very significantly better
over 15'0% and an quality than those of the average UK company
who answers "Northern" [is and therefore deserve to be valued more highly
cheaperl knows the price of
"ffi|?-t"fiftTffi
than the average. It is, in particular, frankly
evefything, but the value period or over 24'0%' absurd. for institutional investors to dismiss
Cadbury shares on the grounds they are over-
of nothing". ."H""?|::ll,?Lll,Tt"t valued. comPared to the UK Food
generate these attractive Manufacturing sector. This is now a sorry
returns. have exhibited extraordinary group of companies, mainly comprising low
durability Dr Pepper was first formulat- margin raw material processors and the manu-
ed in 1885, before Coke and 120 Years facturers of "own-label" goods for the super-
later, its volumes and cash flows are still markets, in whose pockets they firmly sit'
growing. The Dairy MiIk "megabrand"' as Northern Foods sells on a prospective P/E of
Cadbury calls it, was introduced exactly 100 I2.0x, a discount to the market average'
years ago and is today sold in 33 countries Cadbury sells for a prospective 16'0x, a premi-
worldwid.e, with annual retail value of $1'0 bil- um to the All-Share and over 30.0% more
Iion. Bassett's Jelly Babies came to parturition "expensive" than Northern Foods. But over the
in 1918 and now over 1 billion are consumed last decade Cadbury's EBITDA per share is up
every year' Creme Eggs are of more recent 70.0o/o,while Northern's is down 17'0% - which
provenance, 1971, but over 300 million are laid is going to be "cheap" or "expensive" over the
every year at Bournville (a dubious statistic - next ten years? We think anyone who answers
our office secretary must eat over 100 million a "Northern" - "knows the price of everything,
year on her own). Hall's cough drops were but the value of nothing"' WI

52 | Wealth lnsight February 2016